Sources Available for Financing a Small Business

Types of Sources Used to Finance a Small Business Equity sources: Money or capital contributed by owners; capital sources that trade cash for some portion of ownership or equity in a business.  Equity is sometimes called risk capital because the investor puts his/her money at risk.  Since the investor acquires ownership in the business, no repayment of money with interest is required. Debt sources: Sources of funding that require the money borrowed to be paid back with interest.

 Personal savings  Friends and relatives  Partners  Private investors  Venture capitalists  State-sponsored venture capital funds

Personal Savings  Advantages oOwner keeps all the profits. oOwner's risk of loss provides motivation to succeed.  Disadvantages oCreates chance of loss oCauses personal sacrifice oCauses loss of return from use of savings oCarries unlimited liability

Partnership With People or With Other Companies Having Compatible Goods  Advantages oBrings in more cash oShares financial risks and responsibilities oIncreases borrowing power  Disadvantages oRequires giving up a portion of profits oResults in the loss of some control and ownership

Family and friends - Sometimes called "love money"  Advantages oProvides quick and easy source of funds oAllows less formal arrangements oImposes fewer restrictions  Disadvantages oCreates chance of loss oCauses possible loss of return from use of savings oCarries unlimited liability

Private investors - also called Angels: Wealthy individuals functioning as non- professional investors who are willing to invest in local businesses for financial or emotional reasons and who sometimes prefer to remain anonymous.  Advantages oInvest in region in which they live oWill finance startup businesses  Disadvantages oNot easy to locate oMust be chosen carefully and may not always be a reliable source

Venture capitalists : Individuals or firms that invest money professionally to make money, expect a large capital gain, and look for high growth potential (30-50% return on investment).  Advantages oProvide large amounts of money oAllow owner to maintain control and operation of the business oProvide for additional assistance, when available  Disadvantages oMost businesses do not qualify. oEntrepreneur must give up part ownership. oSmall businesses may have trouble attracting venture capitalists.

State-Sponsored Venture Capital Funds : Funds provided to entrepreneurs by the state in an effort to encourage economic development and creation of jobs.  Advantages oCreate jobs oDo not focus solely on profits  Disadvantages oNone noted

Money or capital that is borrowed and must be paid back with interest.  Banks  Trade credit through venders  Finance companies  Credit unions  Government agencies

Analysis of Debt Sources  Advantages oRelatively easy and quick to obtain oMaintain control and ownership of the business oRepay at a more advantageous time oTax deduction for interest and related costs  Disadvantages oHigher interest rates oRisk of insufficient profit to cover repayment oEasy to abuse and overuse oRestrictions and limitations imposed by the lender

1.Most common source of business financing 2.A line of credit allows businesses to borrow a stated amount of money at a stated interest rate to use as the business chooses. 3.Require that money be paid back on a regular basis according to the repayment plan specified 4.Very conservative and not inclined to lend to businesses that are not well established 5.Usually require some kind of collateral Banks

1.Short-term financing 2.Credit from within the industry or trade Example: One may purchase goods on days of credit, interest-free. The business owner then has the use of the money for at least 30 days. Provided customers pay for goods and services on time, the owner can then pay his/her bills on time. Trade Credit Through Vendors

1.Take more risks than banks 2.Are more expensive than banks 3.Will ask for some form of security like the entrepreneur's home, accounts receivable, or business inventories Finance Companies

Credit Unions Cooperatives formed by labor unions or employees for the benefit of the members

1.Terms of repayment may be quite flexible. 2.Interest rate may be low or the loan might be interest free. 3.Mixing financial affairs with family relationships or friendships can sometimes cause problems. Personal Loan From a Family Member or Close Friend

1.Uses a commercial bank to process and release the money and guarantees up to 90% of the loan if the business fails 2.Also lends public funds to veterans and handicapped persons who qualify Government Agencies Small Business Administration (SBA)

Government Agencies Minority Enterprise Small Business Investment Companies (MESBIC's) 1.Established by SBA 2.Provide funding to businesses whose ownership is at least 51% minority, female, or disabled

Government Agencies Small Business Investment Companies (SBIC's)Minority 1.Licensed by SBA 2.Provide equity and debt financing to young businesses 3.Invest about twice as often in startup ventures as do venture capitalists 4.Privately owned 5.Requirements vary

Government Agencies Department of Housing and Urban Development (HUD): Provides grants to cities to lend money to private developers to help improve impoverished areas.

Government Agencies The Economic Development Administration (EDA) 1.Division of the U. S. Department of Commerce 2.Lends money to businesses that operate in and benefit economically distressed parts of the country 3.Similar to SBA, but more restricted 4.Most states have economic development agencies and finance authorities that make or guarantee loans to small businesses.

Government Agencies Local and municipal governments can be sources. Sometimes these agencies make small loans of $10,000 or less